The majority of investments in employer-sponsored retirement plans are mutual funds.1 Mutual funds can help investors build diversified portfolios, potentially benefit from the expertise of professional investment managers, and meet a range of needs and objectives. Let's learn more about them.
Getting To Know Mutual Funds
If you’re invested in an employer-sponsored retirement plan, such as a 401(k) plan, you may be invested in mutual funds. But what exactly are they?
What Are Mutual Funds?
A mutual fund is a type of investment company that operates by pooling money from many investors and investing it in a portfolio of stocks, bonds and/or other securities. The fund is managed by a professional investment manager who invests the portfolio in accordance with the fund’s stated objective.
Benefits of Mutual Funds
Mutual funds are among the many products you may use to help build an investment portfolio. Since most publicly traded mutual funds require only a relatively small initial investment, they can be used by investors of various income and asset levels. In addition, because of the numerous types available, mutual funds can meet a broad range of investor needs and objectives.
These benefits include but are not limited to: professional investment management, diversification, liquidity, easy-to-monitor performance and ease of investment.
Professional Investment Management
Professional investment management is one of the primary reasons people choose to invest in mutual funds. The financial professionals who manage the funds dedicate their attention and analytical skills to keeping abreast of market trends and the performance of the fund’s underlying holdings.
Professional money managers have access to vast amounts of information and other resources necessary to seek to implement their investment strategies. For investors who do not have the time or knowledge of the markets, mutual funds offer a way to potentially benefit from the skill of these managers.
Diversification
Diversification is the process of spreading one’s investments across many different securities, asset classes and/or sectors of the economy. Diversification helps to reduce overall portfolio risk by limiting an investor’s exposure to any one security or type of security. Investing in mutual funds is one of the easiest ways for retail investors to achieve investment diversification.
For example, an equity mutual fund may own stocks of companies in several industry sectors, such as banking, technology and energy, as well as several companies within each sector. Because of this diversification, the negative performance of any one security or sector may be offset by the positive performance from other companies or sectors invested in by the fund. In addition, owning more than one mutual fund may help provide further diversification. Of course, diversification does not guarantee a profit or protect against loss. Further, although mutual funds must meet certain diversification requirements, some mutual funds are more diversified than others.
Liquidity
Liquidity is the ability to convert an asset into cash. In general, mutual funds are required to redeem shares on a daily basis, which means that an investor will have their shares valued at the price next calculated after their redemption order is received. However, depending on certain factors, charges may apply at the time of redemption. Most mutual funds allow investors to exchange shares from one fund to another within the same fund family and share class, often without new charges.
Easy-to-Monitor Performance
The net asset value (NAV) of mutual fund shares is calculated daily based on the closing prices of the securities in the portfolio. NAVs are published in most daily financial publications and on a fund’s website. The availability of information regarding the value of the funds’ shares makes it easy for investors to monitor how their mutual funds are performing and track the value of their holdings.
Ease of Investment
Mutual funds can offer a wide array of services to investors, including:
- Automatic reinvestment of fund distributions and/or dividends.
- Various investor education and shareholder communications.
- Systematic investing, which allows investors to implement dollar-cost averaging, an investment strategy where a fixed dollar amount is invested at fixed intervals, usually monthly or quarterly.
- Systematic withdrawals, which allow investors to withdraw a specific dollar amount from the mutual fund at regular intervals.
Common Types of Mutual Funds
Mutual funds can be classified according to the types of securities in which they invest. Following are some common types of mutual funds; however, they are not limited to these types.
- Equity funds: An equity, or stock, mutual fund invests mostly in the common stock of individual companies. There are many different types of equity funds that differ based on the investment style that they employ, the types of companies in which they invest and the market capitalization of those companies. Investors in an equity fund will bear the risks of equity investing. The value of the fund’s portfolio changes daily and will be affected by specific matters relating to the companies in whose securities the fund invests, as well as other changes that may impact the companies in the fund, such as in interest rates, general market conditions and other political, social and economic developments.
- Fixed income funds: A fixed income mutual fund, often referred to as a bond fund, may invest in a specific type of fixed income security or a broad array of securities, such as U.S. Treasury notes and bonds, government agency bonds, mortgage-backed securities, asset-backed securities, corporate bonds, international bonds and/or municipal bonds. In addition, bond funds may differ based on the duration of the bonds they hold. The fund’s yield and the value of its portfolio will fluctuate and will be affected by specific matters relating to the bonds in which the fund invests, as well as other changes that may impact the bonds in the fund, such as in interest rates, general market conditions and other political, social and economic developments.
- Money market funds: A money market mutual fund invests in short-term debt instruments, including but not limited to CDs, U.S. Treasury Bills and short-term U.S. government agency issues. The average maturity of the securities in the portfolio usually ranges from 30 to 90 days, with most money market funds having average maturities of 60 days or less. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although many, but not all, money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
- Target date funds: A target date fund generally holds both equity and fixed income investments and is designed to provide diversification and convenience to investors. By taking into account the year in which you plan to redeem your investment and reducing your exposure to riskier investments as you near that date, target date funds try to limit the chance that a market shock wipes out a substantial portion of your portfolio as you are getting ready to cash out. For investors who would rather not reassess and tweak their portfolios every year, target date funds may be an effective way to invest.
The Bottom Line
Consider the investment objectives, risks, charges and expenses of any mutual fund carefully before investing. The prospectus contains this and other information about mutual funds. To obtain a prospectus, contact your Financial Advisor. Please read the prospectus carefully before investing.
Footnotes
1 Investment Company Institute, “The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2022.” July 2023.
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not a guide to future performance.
The securities/instruments discussed in this material may not be appropriate for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies and encourages investors to seek the advice of a Financial Advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Investment Advisers Act of 1940, the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.
Companies paying dividends can reduce or cut payouts at any time.
Any type of continuous or periodic investment plan does not assure a profit and does not protect against loss in declining markets. Since such a plan involves continuous investment in securities regardless of fluctuating price levels of such securities, the investor should consider his/her financial ability to continue his/her purchases through periods of low-price levels.
Investing in fixed income securities involves interest rate risk, credit risk, and inflation risk. Interest rate risk is the possibility that bond prices will decrease because of an interest rate increase. When interest rates rise, bond prices, and the values of fixed income securities generally fall. Credit risk is the risk that a company will not be able to pay its debts, including the interest on its bonds. Inflation risk is the possibility that the interest paid on an investment in bonds will be lower than the inflation rate, decreasing purchasing power.
An investment in a target date portfolio is subject to the risks attendant to the underlying funds in which it invests. A target date portfolio is generally geared to investors who will redeem at an approximate year. The portfolio is generally managed to meet the fund’s goals by the pre-established year or “target date.” A target date portfolio will transition its invested assets from a more aggressive portfolio to a more conservative portfolio as the target date draws closer. An investment in the target date portfolio is not guaranteed at any time, including, before or after the target date is reached.
Diversification and asset allocation do not assure a profit or protect against a loss.
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